Rhode Island’s awful investment returns

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It’s getting a little tiresome to hear all the adulation that’s being heaped on Gina Raimondo, the Rhode Island General Treasurer. She’s been praised in the Wall Street Journal, Time, and now CNBC as some sort of fiscal Joan of Arc who rescued the state’s public pension system from insolvency. I’ll give Raimondo credit for leading the charge to reduce benefits to Rhode Island public workers and increasing their retirement age, but she’s far from a pioneer in making tweaks to state pension plans – 17 other states have also made changes recently.

More importantly, the problems Raimondo addressed were not the biggest that the state faced. The main problem with Rhode Island’s pension system is that it has very poor investment returns on its $6.5 billion portfolio of assets. Over the past ten years the state’s investments returned 2.47 percent compared with the national median of 3.4 percent (page 6). These returns are in the lowest tier of state pension plans, and this chronic underperformance is causing a substantial shortage of assets to pay retirees.

A national clearinghouse for public pension fund data, the Public Fund Survey, wrote in its report for FY2010:

Over time, investment earnings have a major effect on the cost and funding condition of a public pension plan: from 1982 through 2009, investment earnings accounted for 60 percent of all public pension revenue.

So the major source of pension plan funding, investment returns on plan assets, has been terrible in Rhode Island. I’m not aware of any discussion or changes in the law to address this issue. Instead, state workers and retirees are carrying the load of getting the pension plan in better shape. The latest pension reform only addressed state worker conditions. Check out this list from WPRI.com:

cost-of-living adjustments (COLAs) may be awarded every 5 years during freeze

all employees except public-safety workers and judges go into the hybrid plan

same funding calculation to end COLA suspension for judges and troopers as others

part-timers will be able to get a pension, but based on 10 highest years to avoid “spiking”

all active workers will get a retirement age between 59 and 67 based on how close they are now

I’m withholding my praise for Gina Raimondo until the investment returns of the Rhode Island pension plan move closer to the national median. Then state workers won’t have to bear the entire burden.

The pension plan is only reflecting market returns. The S&P 500 has gone from 1454 in July 2000 to 1030 in June 2010, which is more a factor in the plan’s returns than any purported mismanagement of fund assets by RI fund administrators. Rhode Island’s 2.47% return has underperformed the state average by 93 basis points; there are 18 other states that had returns ranging from 1.2% to 2.99% over that same period. Only eight states, according to the graph, had returns of 4% or better. RI’s investment returns are hardly the outlier that you’d like to make them out to be.
The bigger problem with RI and most pension funds is return assumptions that are completely out of touch with reality. Even after a decade of poor market returns, the RI plan assumes an 8.25% annual return, which is only .25% higher than the average for all plans according to the Boston College Center for Retirement Research. RI’s return assumptions missed actual returns by over 550 basis points – a slightly more egregious “miss” than the actual return (2.47%) variance from average (3.4%).
Sure RI could improve performance and should strive to do so, but even if returns had been on par with the national average it’s hard to believe that the state would have been in an appreciably better position today. You say, “I’m not aware of any discussion or changes in the law to address the issue”. How exactly do you propose that the state of RI is going to have a discussion or write a law that will boost market returns to match their outsized return assumptions? What should be discussed is shaving 200-400 basis points from expected returns, but that will never happen because it would paint the plan as even more severely underfunded, and that’s not going to get anyone re-elected.
When the market doesn’t provide returns, pensioners need to adjust return expectations or increase contributions to make the plan whole. That’s reality – and RI is just wising up to it a little bit faster than others. Give a little credit where credit is due.

The article correctly states that many states are active with pension reform laws, and RI’s success in this regard is not unique, though you could wish the writer was not so parsimonious in her praise.

In RI we’ve seen a couple of previous reform rounds, but without the 2011 pension reform, taxpayer contributions were schedule to increase from 22% to 35% of payroll for both teachers and state workers beginning in June, 2012. No doubt many folks including Gina Raimondo, deserve a share of the credit for recognizing, and solving, the problem.

Hopefully, Ms Raimondo, a first term Treasurer, will be around long enough to develop a track record on the writers preferred investment metric, the 10 year fund returns.

Thanks so much for providing this information as well as your analysis. The Treasurer’s response to these dismal returns was that she’s “keeping an eye on risk.” Even with a risk averse portfolio, I find it hard to believe that she can’t do better for the state retirees, especially given her expertise in investing.

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I’m Cate Long and I write about the retail fixed income markets including municipal bonds. My primary interest is creating tools and systems to help retail investors understand bond markets. I’ve worked for a number of years with industry standards organizations, regulators and Congress to help craft a more transparent and fair framework for investors to participate in the fixed income markets. I'm a guest contributor to Reuters.com. Any opinions expressed are mine alone.